Should You Like Kelso Technologies Inc.’s (TSE:KLS) High Return On Capital Employed?

June 15, 2020

Today we'll evaluate Kelso Technologies Inc. (TSE:KLS) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Kelso Technologies:

0.25 = US$3.3m ÷ (US$16m - US$2.9m) (Based on the trailing twelve months to March 2020.)

Therefore, Kelso Technologies has an ROCE of 25%.

Check out our latest analysis for Kelso Technologies

Does Kelso Technologies Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Kelso Technologies's ROCE appears to be substantially greater than the 10% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Kelso Technologies's ROCE is currently very good.

Kelso Technologies reported an ROCE of 25% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. The image below shows how Kelso Technologies's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSX:KLS Past Revenue and Net Income June 16th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Kelso Technologies is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Kelso Technologies's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Kelso Technologies has total assets of US$16m and current liabilities of US$2.9m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

The Bottom Line On Kelso Technologies's ROCE

, There might be better investments than Kelso Technologies out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

I will like Kelso Technologies better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.